Obama was too cautious in fearful times: Suppose that the US presidential election of 1932 had, in fact, taken place in 1930, at an early stage in the Great Depression. Suppose, too, that Franklin Delano Roosevelt had won then, though not by the landslide of 1932. How different subsequent events might have been. The president might have watched helplessly as output and employment collapsed. The decades of Democratic dominance might not have happened.
On such chances the wheel of history turns. But this time was different: the crisis brought Barack Obama to power close to the beginning of the economic collapse. I (among others) then argued that policy needed to be hugely aggressive. Alas, it was not. I noted on February 4 2009, at the beginning of the new presidency: “Instead of an overwhelming fiscal stimulus, what is emerging is too small, too wasteful and too ill-focused.” A week later, I asked: “Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much.” This was right.
The direction of policy was not wrong: policymakers – though not all economists – had learnt a great deal from the 1930s. Sensible people knew that aggressive monetary and fiscal expansion was needed, together with reconstruction of the financial sector.
But, as Larry Summers, Mr Obama’s chief economic adviser, had said: “When markets overshoot, policymakers must overshoot too”. Unfortunately, the administration failed to follow his excellent advice. This has allowed opponents to claim that policy has been ineffective when it has merely been inadequate. In consequence, the administration has lost credibility with the public and the chances of a renewed fiscal expansion have disappeared. With the Federal Reserve cautious, too, the likelihood of a lengthy period of weak growth and heavy joblessness is high. So, too, are the chances of domestic and global political friction.
True, the idea that the policies adopted in the last few months of the Bush administration and the first months of this one were far better than nothing is weirdly controversial in the US. A recent paper by Alan Blinder, former vice-chairman of the Fed, and Mark Zandi of Moody’s argues that such critics are wrong....
A fascinating perspective does come, however, from comparisons with what happened in other advanced countries. The recession in US output (and so demand) has been relatively small, but the decline in employment has been exceptionally large, as a result of an extraordinary surge in US productivity (see charts). This contrast between what would happen to output and what would happen to employment was missed in the initial Congressional Budget Office analysis of the stimulus....
Debate is emerging on how much of the surge in unemployment is structural. My answer, from European experience, is that one way to ensure it becomes structural is to let it linger. In the short run, the simplest way to prevent that from happening is to expand demand and so output. Since there is huge slack in the labour market, not the slightest threat of inflation – far more a risk of deflation – and no constraint from bond or foreign exchange markets on further monetary and fiscal stimulus, these are the policies that have to be pursued. Yet, alas, the Fed seems to have decided to fall asleep and the administration has lost the initiative.
So what is going to happen? I assume that, after the midterm elections, resurgent Republicans will offer new tax cuts and ignore the fiscal deficits. They will pretend that this has nothing to do with any reviled stimulus, though it is much the same thing – increasing fiscal deficits, thereby offsetting private frugality. That would put the administration on the spot. It would have to choose between vetoing the tax cuts and accepting them, so allowing the Republicans to get the credit for their “yacht and mansion-led” recovery. Any recovery is better than none. But it could have been much better than this. Those who were cautious when they should have been bold will pay a big price.